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Concise Notes for Cost & Management Accounting

Index Table
S.No. Topic Page No.
Chapter 1 Material Costing 2-4
Chapter 2 Employee Cost & Direct Expenses 4-7
Chapter 3 Overheads: Absorption Costing Method 7-14
Chapter 4 Activity Based Costing (ABC) 14-18
Chapter 5 Cost Sheet 18-20
Chapter 6 Cost Accounting Systems 20-22
Chapter 7 Job Unit & Batch Costing 22-24
Chapter 8 Contract costing 24-27
Chapter 9 Process & Operation Costing 27-29
Chapter 10 Joint Product & By Product 29-31
Chapter 11 Service Costing (Operating Costing) 31-33
Chapter 12 Standard Costing 33-39
Chapter 13 Marginal Costing 40-42
Chapter 14 Budget & Budgetary Control 42-44

“When nothing seems to help, I go & look at a stonecutter hammering away at his rock, perhaps a
hundred times with no crack showing in it. Yet at the hundred-and-one blow it will split in two, and
I know it was not that last blow that did it, but all that had gone before.” Remember failure is not
final until you make it final.

The difference between success and failure is patience and persistence.

Arise Awake and stop not till the goal is reached- Swami Vivekanand Ji
Never disrespect your mother or disappoint her. Do not hurt her feelings. Try to satisfy her in all
manner. Only than the seed of devotion will sprout in you. Everyone should follow the dictum -

“ भ ।”

Nothing in the world can take the place of Perseverance, Talent will not: Genius will not, Education
will not;
Persistence and Determination alone are omnipotent

PUSH YOURSELF, BECAUSE NO ONE ELSE IS GOING TO DO IT FOR YOU.

Dream needs aimless effort and aim needs dream less effort

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Material Costing
Concise Notes
 Material cost:-Purchase price + Total ordering cost + Total carrying cost (T/C/C).
 Purchase price = Number of units purchased × Price per unit
 Cost of placing an order includes quotations, documentation cost, Preparation of purchase order.
 Total ordering cost = Number of orders × Ordering cost per order

 Ordering Cost =

 Number of orders =

 Total carrying cost = Average stock × Carrying cost per unit per annum (C.C.P.U.P.A)
 Average stock = ½ × order size (Standard assumption)
 In case C.C.P.U.P.A is given in the percentage than it is applied on the purchase price.
 If discount is given by the vendor than C.C.P.U.P.A for computing the EOQ is applied on purchase
price and not on the original price.
 Cash discount should be ignored but trade discount and quantity discount should be subtracted
from landing price.
 Subsidies or grants received subtracted from landing price.
 Duties & taxes basic custom duty, road tax, toll tax are added in landing price. IGST,CGST and
SGST or any other tax on which input credit is available should be ignored while computing the
landing price.
 Other expenditure like insurance, brokerage, freight, cost of container (to the extent non-refundable)
should be added in the cost of purchase.
 Expenditure like penalty, detention charges, Demurrage (penalty imposed by transporter for delay in
uploading or off-loading material) or any other abnormal charges should be ignored.
 For computing the frequency of order or the number of days between one order to another we
should divide the number of days in the said period with the number of orders in that period. E.g.
Annual demand = 40,000kgs, Economic order quantity = 2,000 kg then the number of order required
will be 40,000kg ÷2,000kg = 20 order now the frequency of order will be (365days ÷ 20 orders) =
18.25 or 19 days.
 Treatment of Abnormal and normal loss:- While computing the cost per unit normal loss should
be considered through which cost per unit will be increased, On the other hand Abnormal loss should
be ignored and it will be transferred to costing P&L account.

1. Economic Order Quantity (E.O.Q):- The size of the order for which both ordering and carrying cost are at
minimum is known as economic order quantity or E.O.Q. E.O.Q is used in an optimizing stock control system

Economic Order Quantity = √

A= Annual consumption of raw material; C= Carrying Cost/ Holding Cost per unit per annum;
O= Ordering Cost
 At E.O.Q:-Total carrying cost = Total Ordering cost however, IF Order size is in fraction than due to
round off it will not be equal.
 Due to the discount given by vendor cost may be not least at EOQ. In that case any other order
quantity gives us least outflow
2. Minimum Level of stock = Re-order level – (Average consumption × Average lead time)

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3. Maximum level = Re-order level + Re-order Quantity – (Minimum consumption × Minimum re-order period)
4. Re-order level = Maximum consumption × Maximum lead time; OR
Re-order level = (Normal usage ×Average lead time) + Minimum stock level; OR
Re-order level =Safety stock + Lead time consumption

5. Average Stock level =

OR
6. Average stock = Minimum stock level + ½ of Re-order Quantity
7. Danger stock Level = Average consumption* × Lead time for Emergency purchase
*Minimum consumption can also be used.
Buffer stock:-To meet sudden demand.
8. Order point = (Lead time × Normal usage during lead time) + Safety stock

9. Safety Stock = × (Maximum lead time – Average lead Time)

10. Inventory turnover Ratio =

Average inventory =

Cost of raw material consumed = Opening stock + Purchases – Closing stock

Average holding period =

ABC Analysis
It is a system of inventory control. It exercises discriminating control over different items of stores classified
on the basis of the investment involved. Items are classified into the following categories:
A Category: Quantity less than 10 % but value more than 70%
B Category: Quantity less than 20 % but value about 20 %
C Category: Quantity about 70 % but value less than 10%
Inventory valuation:-
Historical methods:-
1. First-In-First Out:-The materials received first are to be issued first when material requisition is received.
Materials left as closing stock will be at the price of latest purchases.
2. Last-in-last out:-The materials purchased last are to be issued first when material requisition is received.
Closing stock is valued at the oldest stock price.
3. Simple average method:-Under this method, materials issued are valued at average price, which is
calculated by dividing the total of all units rate by the number of unit rate.

Material issue price =

4. Weighted Average Price Method:- This method gives due weights to quantities purchased and the
purchase price, while, determining the issue price. The average issue price here is calculated by dividing the
total cost of materials in the stock by total quantity of materials prior to each issue.

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Material issue Price =

5. Specific identification Method:- This method is used when inventory is not deal on regular basis.
Non-Historical Cost Method:-
Adjusted Selling Price Method:-Where it is not possible to find cost of every individual unit.

Labour Costing
Concise Notes
Labour cost = Wages paid + other benefits paid to the worker
Wages includes wages and salary, Allowances and incentives, Payment for overtimes, Employer’s
contribution to Provident fund and other welfare funds, other benefits (leave with pay, free or subsidised
food, leave travel concession etc.) etc.
Other benefit includes overtime, overtime premium and incentives, leave with pay, free or subsidised food,
leave travel concession etc.
System of Wages & Payment & Incentives:-
 Time based (Time Rate)
 Output Based (Piece Rate)
 Combination of Time and output based system
 Premium Bonus
 Group Bonus Scheme
 Incentive for Indirect Employees
Time based wages can be classified into Normal time rate and Differential time rate.
Normal time rate wages = Number of hours worked × Wage rate
Differential time rate:-Under this method different hourly rates are fixed for different levels of efficiency.
Upto a certain level a fixed rate is paid and based on the efficiency level the hourly rate increases gradually.
E.g. For instance, under Emerson Efficiency plan Performance below 66.67% than Time rate wage is
applicable; Performance between 66.6667% to 100% time rate + Bonus between 0.01% to 20%; Performance
is above 100% than Time rate + Bonus 20% + 1 % for each 1% increase in efficiency in excess of 100%.
Idle time:-Ideal Time it can be classified into two category Normal idle time and Abnormal idle time. Cost of
normal idle time will be treated as part of cost of production and cost of abnormal idle time is transferred to
costing profit & loss account.
E.g. of Normal idle time is time lost between factory gate and the place of work, setting up time, lunch/break
time, time in shifting from one to other place.
E.g. of Abnormal time is power failure, break down of machines, strikes, fire, non-availability of raw material
and waiting time etc.
Wages on the basis of quantum of output:-
Straight piece rate:-It is the number of units produced by the worker multiplied by rate per unit. In formula
form it represent as follows:-
Wages = Number of units produced x Piece rate per unit
E.g. Number of units produced by a worker in a day = 2200; Piece rate per unit = ₹ 0.50;
Wage for a day = 2200 x ₹ 0.50 = ₹ 1100
Differential piece rate:-Under differential piece rate system different piece rate slabs are used for different
efficiency or activity level. Efficiency is measured against the standard output level.

Formula of efficiency (Production basis) = x 100

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Formula of efficiency (Time basis) = x 100

Effective hours = Gross hours – Normal idle time

E.g. Standard output in 10 hours is 240 units; actual output in 10 hours is 264 units. Wages rate is ₹ 10 per
hour. Calculate the amount of bonus and total wages.
Answer:-
Calculation of efficiency = (Actual output ÷ Standard Output) x 100; = (264 ÷ 240) x 100 = 110%.
Wages = Time rate + Bonus 20% + 1% for each 1% increase in efficiency in excess of 100%
Wages = 10 hours x ₹ 10 per hour + (100 x 20% + 10% of ₹ 100) = ₹ 130
Premium Bonus method can be classified into two methods:-
Halsey premium Plan:-wages is computed as per the following formula
Total wages = Number of hours worked × Wage rate per hour + 50% (Time saved × wage rate per hour)
E.g. Standard time = 10 hours; Actual time taken = 8 hours; Wage rate = ₹ 70 per hour
Wages = 8 hours x ₹ 70 per hour + 50% (2 hours x ₹ 70 per hour)
Wages = ₹ 630
Rowan’s premium plan:-

Total wages = Number of hours worked × Wage rate per hour + ( ×Time taken ×rate per hour)

E.g. Standard time = 10 hours; Actual time taken = 8 hours; Wage rate = ₹ 70 per hour

Wages = 8 hours x ₹ 70 per hour + ( x 8 hours x ₹ 70 per hour)

Wages = ₹ 672
Over Time
Work done beyond normal working hours is known as ‘overtime work’. Overtime payment is the amount of
wages paid for working beyond normal working hours. Overtime payment consist of two elements- (i)
Normal wages for overtime work and (ii) Premium payment for overtime work.
Overtime premium: The rate for overtime work is higher than the normal time rate; usually it is at double
the normal rates. The extra amount so paid over the normal rate is called overtime premium.
Rate and conditions for overtime premium may either be fixed by an entity itself or it may be required by any
statute in force. The overtime premium should not be less than the premium calculated as per the statute.
Treatment of overtime premium in cost accountancy:-
 On customer’s demand:- Charge to Job
 Due to abnormal situation:- Costing P&L
 Permanent in Nature:- Inflate wage rate
 Irregular to meet production requirements:- Factory overheads
Absorption rate of employee cost:-Employee cost as stated above includes monetary compensation and
non-monetary benefits to workers.
E.g. of monetary benefit is basic wages, D.A., overtime pay, incentive or production bonus contribution to
employee provident fund, H.R.A., Holiday and vacation pay etc.
The non-monetary benefits include medical facilities, subsidized canteen services, subsidized housing, and
education & training facilities.
Accounting of monetary and non-monetary items treated as overhead and absorbed on the basis of rate per
direct employee hour, if overheads are predominantly employee oriented.

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Absorption rate of employee cost =

Labour turnover Ratio:-

Employee turnover or labour turnover in an organisation is the rate of change in the composition of employee
force during a specified period measured against a suitable index. There are three methods of calculating
Employee turnover which are given below:-

Replacement Method = x 100

Separation Method = x 100

Flux Method = x 100

OR

Flux Method = x 100

Total number of worker joining including replacement is called accessions.

Average number of employees =

Equivalent Employee turnover rate = x 365

Time Keeping: It refers to recording and keeping of the employees’ attendance time.
Time Booking: It is basically recording the details of work done and the time spent by an employee on each
job or process.
E.g. Calculate Labour turnover rate:
No. of workers as on 01.01.2013 = 7,600; No. of workers as on 31.12.2013 = 8,400
During the year, 80 workers left while 320 workers were discharged 1,500 workers were recruited during
the year of these, 300 workers were recruited because of exits and the rest were recruited in accordance with
expansion plans.
Answer:
Calculation of labor turnover rate by using the following methods:-
Separation method

Labour turnover rate = x 100

Average number of employees =

Average number of employees = = 8,000 employees

Number of employees separated during the year = 80 + 320 = 400 employees.

Labour turnover = x 100 = 5%

Replacement Method

Labour turnover rate = x 100

Number of employees replaced during the year = 300 employees.

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Labour turnover = x 100 = 3.75%

Flux Method

Labour turnover rate = x 100

Labour turnover rate = x 100 = 23.75% Or

Labour turnover rate = × 100

Labour turnover rate = x 100 = 23.75%

Overheads Costing
Concise Notes
Meaning of overheads:-
Indirect cost associated with the production. Such expenses are incurred for output generally and not for a
particular work order e.g., wages paid to watch and ward staff, heating and lighting expenses of factory etc.
Overheads also represent expenses that have been incurred in providing certain ancillary facilities or
services which facilitate or make possible the carrying out of the production process; by themselves
these services are not of any use. In simple words all the expenses of service department are overheads and
re-distributed to the production department. This distribution is known as secondary distribution.
Classification of Overheads:-
By Function
i. Factory or Manufacturing or Production Overheads:-E.g. Stock keeping expenses, Repairs and
maintenance of plant, Depreciation of factory building, Indirect labour, Cost of primary packing etc.
ii. Office & Administration overheads:- E.g. Salary paid to office staffs, Repairs and maintenance of
office building, Depreciation of office building, Postage and stationery, Lease rental in case of
operating lease (in case of finance lease, lease rental excluding finance cost, Accounts and audit
expenses etc.
iii. Selling & Distribution overheads include:-
 Selling overhead:-Expenses related to sale of products and include all indirect expenses in sales
management for the organisation. E.g. Salesmen commission, Advertisement cost, Sales office
expenses etc.
 Distribution overhead: Cost incurred on making product available for sale in the market. E.g.
Delivery van expenses, Transit insurance, Warehouse and cold storage expenses, Secondary
packing expenses etc.
By Nature
i. Fixed overheads:-E.g. Salary paid to permanent employees, Depreciation of building and plant and
equipment, Interest on capital, Insurance
ii. Variable overheads:-Indirect materials, Power and fuel, Lubricants, Tools and spares etc.
iii. Semi-Variable Overheads:-Electricity cost, Water cost, Telephone and internet expenses etc.
By Element
i. Indirect Material:-E.g. Stores used for maintaining machines and buildings (lubricants, cotton
waste, bricks etc.), Stores used by service departments like power house, boiler house, canteen etc.
ii. Indirect Employee Cost:-E.g. Salary paid to foreman and supervisor, Salary paid to administration
staff etc.
iii. Indirect Expenses:-Rates & taxes, Insurance, Depreciation, Advertisement expenses etc.
By Control
i. Controllable Cost:-Materials cost, Wages and salary, Power and fuel etc.
ii. Uncontrollable costs:-Rates and taxes, Depreciation, Interest on borrowings

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In primary distribution overheads are distributed to production and service departments either through
allocation or re-apportionment.
 Allocation means expenses which are directly related to the department. E.g. raw material used in
service department.
 Apportionment means distribution of overhead cost to various departments. E.g. Distribution of
factory rent.
Difference between allocation and Apportionment: -
 Allocation deals with the whole items of cost, which are identifiable with any one department. For
example, indirect wages of three departments are separately obtained and hence each department will
be charged by the respective amount of wages individually. On the other hand, apportionment deals
with the proportions of an item of cost for example; the cost of the benefit of a service department
will be divided between those departments which has availed those benefits.
 Allocation is a direct process of charging expenses to different cost centres whereas apportionment is
an indirect process because there is a need for the identification of the appropriate portion of an
expense to be borne by the different departments benefited.
Statement showing the basis of apportionment of overheads:-

Overhead Cost Bases of Apportionment

1. (i) Rent and other building expenses
(ii) Lighting and heating (conditioning)
Floor area, or volume of department
(iii) Fire precaution service
(iv) Air- conditioning
2. (i) Perquisites
(ii) Labour welfare expenses
(iii) Time keeping Number of workers
(iv) Personnel office
(v) Supervision
3. (i) Compensation to workers
(ii) Holiday pay
Direct wages
(iii) ESI and PF contribution
(iv) Perquisites
4. General overhead Direct labour hour, or Direct wages, or Machine
hours.
5.(i) Depreciation of plant and machinery
(ii) Repairs and maintenance of plant and Capital values
machinery
(iii) Insurance of stock
6. (i) Power/steam consumption
(ii) Internal transport Technical estimates
(iii) Managerial salaries
7. Lighting expenses (light) No. of light points, or Area or Metered units

8. Electric power (machine operation) Horse power of machines, or Number of machine

hour, or value of machines or units consumed.
9. (i) Material handling Weight of materials, or volume of materials, or
value of materials or unit of materials.
(ii) Stores overhead

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Secondary Distribution:-Overheads of service department are distributed to production department.

The re-apportionment of service department expenses over the production departments may be carried out
by using any one of the following methods:
1. Direct Re-distribution method:-
Service department costs under this method are apportioned over the production departments only,
ignoring the services rendered by one service department to the other.
 E.g. Three production departments P1, P2, P3 and two service departments S1, S2. Service department cost
for stores, Time keeping and Power is ₹4,00,000, ₹3,00,000 and ₹ 1,60,000 respectively. Number of workers
in P1 is 20, in P2 is 15 and in P3 is 15. Horse power of machine used in P1 is 300; in P2 is 300; and in P3 is
200. ratio of store requisition is 5:3:2.
Statement showing the apportionment of service department cost to production departments:-
Production Department
Particulars P1 P2 P3 Total
Stores cost (5:3:2) (value of store requisition) 2,00,000 1,20,000 80,000 4,00,000
Time Keeping (4:3:3)(No. of workers) 1,20,000 90,000 90,000 3,00,000
Power (3:3:2) (horse power of machine) 60,000 60,000 40,000 1,60,000

2. Step Method or Non-Reciprocal Method:-

 This method is used when one service department provides service to other service department.
 A Service department which is providing services to highest service departments is considered first
in reapportionment.
 E.g. suppose the expenses of two production departments A and B and two service departments X and Y are
as under:

Apportionment Basis
Department Amount (₹) Y A B
X 2,00,000 25% 40% 35%
Y 1,50,000 - 40% 60%
A 3,00,000 - - -
B 3,20,000 - - -
Solution:-
Departments X (₹) Y (₹) A (₹) B (₹)
Amount as given above 2,00,000 1,50,000 3,00,000 3,20,000
Expenses of X Dept. apportioned over Y,A & B(5:8:7) (2,00,000) 50,000 80,000 70,000
Expenses of Y Dept. apportioned over A & B (2:3) (2,00,000) 80,000 1,20,000
Total 0 0 4,60,000 5,10,000

3. Reciprocal Service method:-

This method is used when two or more service departments render service to each other. These inter-
departmental services are to be given due weight while re- distributing the expenses of the service
departments. The methods available for dealing with reciprocal services are:
i. Simultaneous equation method;
ii. Trial and error method;
iii. Repeated distribution method.
i. Simultaneous equation method:-According to this method firstly, the costs of service departments are
ascertained. These costs are then re-distributed to production departments on the basis of given
percentages. E.g. Boiler house expenses is ₹ 3,00,000 and pump room expenses ₹ 60,000.
Allocation is as follows:-
Production Department Service Department
Particulars A B Boiler Pump
Expenses of Boiler house (% of allocation) 60% 35% - 5%
Expenses of Pump Room (% of allocation) 10% 40% 50% -

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Total overheads of Boiler house = ₹ 3,00,000 + 50% of pump………(i)

Total overheads of Pump room = ₹ 60,000 + 5% of Boiler house………(ii)
From (i) & (ii)
Total overheads of Boiler house = ₹ 3,00,000 + 50% of (₹60,000+5% of Boiler)
Total overheads of Boiler house = 3,00,000 + 30,000 + 2.5% of Boiler house
0.975 Boiler house = ₹ 3,30,000; Boiler house = ₹ 3,38,462
Cost of Pump house = ₹ 60,000 +5% of ₹3,38,462
Cost of Pump house = 76,923

Particulars A B
Re-apportionment of Boiler house expense 3,38,462 x 60% = ₹2,03,077 3,38,462 x 35% =₹1,18,462
Re-apportionment of Pump house expense 76,923 x 10% = ₹7692 76,923 x 40% = ₹30,769
Total 2,10,769 1,49,231

ii. Trial & Error Method:-According to this method the cost of one service cost centre is apportioned to
another service cost centre. The cost of another service centre plus the share received from the first cost
centre is again apportioned to the first cost centre. This process is repeated till the amount to be apportioned
becomes negligible, that means repeated distribution method is followed to the extent of service
departments only. All apportioned amounts for each service cost centre are added to get the total
apportioned cost. These total service cost centre costs are redistributed to the production departments. Trial
and error method and Simultaneous equation method gives the same result.
iii. Repeated Distribution Method:-Under this method, service departments’ costs are distributed to other
service and production departments on agreed percentages and this process continues to be repeated, till
the figures of service departments are either exhausted or reduced to too small a figure. If question does not
specify the method then use repeated distribution method.
Recovery Rate:-Method of charging overheads to production. Several methods are commonly employed
either individually or jointly for computing the appropriate overhead rate. The more common of these are:-
i. Percentage of Direct material
ii. Percentage of Prime Cost
iii. Percentage of Direct Labour Cost
iv. Labour hour rate
v. Machine Hour rate
vi. Rate per unit of output.
i. Percentage of direct material cost:-Under this method, the cost of direct material consumed is the base
for calculating the amount of overhead absorbed. This overhead rate is computed by the following formula:

Percentage of Direct material = x 100

 E.g. Direct material = ₹ 10,00,000; Overheads = ₹6,00,000; Job X = Direct material = ₹ 50,000; Job Y direct
material = ₹ 70,000

Percentage of Direct Material = x 100 = 60%

Allocation of overheads to job X = 50,000 x 60% = ₹ 30,000;

Allocation of overheads to job Y = 70,000 x 60% = ₹ 42,000
Total cost for Job X = 50,000+30,000 = 80,000; Total cost for Job Y = 70,000+42,000 = ₹ 1,12,000

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ii. Percentage of Prime cost method:-This method is based on the fact that both materials as well as labour
contribute in raising factory overheads. Hence, the total of the two i.e. Prime cost should be taken as base for
absorbing the factory overhead. The overhead rate in this method is computed by the following formals:

Percentage of Prime cost = x 100

 E.g. Job X:-Direct material = ₹ 3,00,000; Direct Labour = ₹2,00,000; Factory overheads =₹1,00,000

Prime Cost = ₹5,00,000; Percentage of Prime cost = x 100 = 20%

Direct Material cost for Job Y = 30,000; Direct Labour cost for Job Y = ₹ 10,000; Prime cost = 40,000
Allocation of Factory overheads to Job Y = ₹40,000 x 20% = ₹8,000
iii. Percentage of Direct Labour cost:-Under this method, the direct labour hour is the base for calculating
the amount of overhead absorbed. This overhead rate is computed by the following formula:

Direct Labour cost = x 100

 E.g. Direct Material = ₹80,000; Direct Labour = ₹1,20,000; factory Overheads = ₹ 60,000
Job M = Direct Material = ₹ 35,000; Direct Labour = ₹25,000

Percentage of direct labour cost = x 100 = 50%

Allocation of overheads to Job M = ₹ 25,000 x 50% = ₹ 12,500

iv. Labour Hour Rate:-As it fully recognises the significance of the element of time in the incurring and
absorption of manufacturing overhead expenses. This method is admirably suited to operations which do not
involve any large use of machinery. To calculate labour hour rate, the amount of factory overheads is
divided by the total number of direct labour hours.

Percentage of Direct labour cost = x 100

 E.g. A product is processed for 5 hours in department ‘B’. Material used = ₹ 3,000 & Direct labour = ₹ 200

Percentage of direct Labour cost = x 100 = ₹ 4 per hour

Overhead = 5 hours x ₹4 per hour = 20; Total cost = ₹ 3,220

iv. Machine Hour rate:-Machine hour rate implies, cost of running a machine for an hour to produce goods.

Machine hour rate = = Machine hour rate

 E.g. Department ‘A’ overhead = ₹ 2,00,000; Machine Hours = 25,000 hours.

A product is processed in 4 hours in Department A. Direct Material = ₹1,000 & Direct wages = ₹400

Machine hour rate = = ₹ 8 per hour

Direct Material = ₹ 1,000; Direct wages = ₹ 4,00; Overheads = ₹ 32 (4 hours x ₹ 8 per hour)
Total overhead = ₹1,432
Rate per unit of output:-

Rate per unit of output =

Rate per unit of output = = ₹ 10 per hour

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 Variable cost is always proportionate on productive time basis.

 Fixed cost is always proportionate on Production time.
Blanket Overhead Rate: Blanket overhead rate refers to the computation of one single overhead rate for
the whole factory. The use of blanket rate may be proper in certain factories producing only one major
product in a continuous process or where the work performed in every department is fairly uniform or
standardised.

Blanket rate =

Two Tier rate:-This concept is used when setup time is productive and the cost of set up time is not
same as running time.
Allocation of Fixed expenses Setup + Running Time
Allocation of variable expenses Only Running Time
E.g. Repair Cost Repair & Maintenance Cost Maintenance Cost

Variable Question will specify (better to assume variable) Fixed

Finance cost is not considered in costing. E.g. Interest on capital outlay.
Effective machine hour:-It is the expected time to be available in a certain period of time. It is computed
after subtracting the expected holiday form the Gross available time and multiplying the result with expected
efficiency rate.
Note:-Overhead recovery rate is computed by using budgeted data as we need to decide selling price in the
beginning & for that we need cost of production including overheads.
Treatment of under-absorbed and over–absorbed overheads in cost accounting
1. Overhead expenses are usually applied to production on the basis of pre- determined rates.
Production overheads are to be determined in advance as follows for fixing selling price, quote
tender price and to formulate budgets etc.
2. As regards the treatment of such debit or credit balances, if the balances are small they should be
transferred to the Costing Profit and Loss Account and the cost of individual products should not be
increased or reduced as these would be representing normal cost.
3. If under absorbed and over absorbed amount is large and due to wrong estimation, it would be
desirable to adjust the cost of products manufactured. Such adjustments usually take the form of
supplementary rates where there is a debit balance in the overhead account and a credit in the other
case.
4. However, over or under recovery of overheads due to abnormal reasons (such as abnormal over or
under capacity utilisation) should be transferred to the Costing Profit and Loss Account.
 Example on Supplementary Rate:-Based on Labour Hour
Overhead absorption rate = ₹ 8 per hour based on budgeted time of 3,000 labour hour. Actual hour worked is
2400.
Actual overhead incurred in the entire period is 3000 hours x ₹ 8 per hour = ₹ 24,000
Revised actual overhead rate = = ₹ 10 per hour
Supplementary rate = ₹ 10 per hour - ₹ 8 per hour = ₹ 2 per hour
Now the unabsorbed overheads are recovered by using the supplementary rate on particular job.
 Example on Supplementary Rate:-Based on Machine Hours
Two machine in a factory M1 and M2. Normal working hours = 40. Overhead rate for M1 is ₹ 45 per hour and
for M2 is ₹ 65 per hour. Actual machine hours for M1 is 30 and for M2 is 32.50.
Budgeted overheads incurred for M1 = 40 hours x ₹ 45 per hour = ₹ 1,800
Budgeted overheads for M2 = 40 hours x ₹ 65 per hour = ₹ 2600
Actual rate for M1 = = ₹ 60 per hour

Actual rate for M2 = = ₹ 80 per hour

Supplementary rate for M1 = ₹ 60 - ₹ 45 = ₹ 15 per hour

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Supplementary rate for M2 = ₹ 80 - ₹ 65 = ₹ 15 per hour

Accounting of Administrative overheads:-
There are three distinct methods of accounting of administrative overheads, which are briefly discussed
below:-
1. Apportioning Administrative Overheads between Production and Sales Departments:-
The reason for the apportionment of overhead expenses over these departments recognises the fact that
administrative overheads are incurred for the benefit of both of these departments. When this method is
adopted, administrative overheads lose their identity and get merged with production and selling and
distribution overheads.
2. Charging to Profit and Loss Account:-
According to this method administrative overheads are charged to Costing Profit & Loss Account. Reason for
charging the overheads to costing profit & loss account is that, not directly concerned with either the
production or the selling and distribution functions. Second reason is it is difficult to determine a suitable
basis for apportioning administrative overheads over production and sales departments.
3. Treating Administrative Overheads as a separate addition to Cost of Production/ Sales:-
This method considers administration as a separate function like production and sales and, as such costs
relating to formulating the policy, directing the organisation and controlling the operations are taken as a
separate charge to the cost of the jobs or a product, sold along with the cost of other functions.
The basis which are generally used for apportionment are:-
 Works cost
 Sales value or quantity
 Gross profit on sales
 Quantity produced
 Conversion cost, etc.
Accounting of Selling & Distribution overheads:-
Sale value is ordinarily the most logical basis, there being some connection between the amount of sales
and the amount of expenses incurred to achieve them. The best method for absorbing selling and distributing
expenses over various products is to separate fixed expenses from variable expenses. Apportion the fixed
expenses according to the benefit derived by each product and thus ascertaining the fixed expenses per unit.
If a suitable basis for apportioning expenses does not exist it may be apportioned in the proportion of
sales of various products.
E.g.
Expenses Basis
Salaries in the Sales Department and of
the sales men. Estimated time devoted to the sale of various products.
Actual amount incurred for each product since these days it is
usual to advertise each product separately; common expenses,
such as in an exhibition, should be apportioned on the basis of
Advertisement advertisement expenditure on each product.
Show Room expenses Average space occupied by each product.
Rent of finished goods godowns and
Expenses on own delivery vans Average quantities delivered during a period.
Treatment of certain items in costing:-
 Interest and financing charges:-It does not include imputed costs. Interest and financing charges
shall be presented in the cost statement as a separate item of cost of sales.
 Depreciation:-It shall be traced to the cost object to the extent economically feasible. Where it is not
directly traceable it should be assigned using either or two principles i.e. Cause and Effect and Benefit
received.
 Packing expenses:-Cost of primary packing necessary for protecting the product or for convenient
handling, should become a part of the production cost. The cost of packing to facilitate the
transportation of the product from the factory to the customer should become a part of the
distribution cost. If the cost of special packing is at the request of the customer, the same should be
charged to the specific work order or the job. The cost of fancy packing necessary to attract
customers is an advertising expenditure. Hence, it is to be treated as a selling overhead.
 Fringe benefits:-If the amount of fringe benefit is considerably large, it may be recovered as direct
charge by means of a supplementary wage or labour rate; otherwise these may be collected as part of
production overheads.

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 Expenses on removal and re-erection of machines:-All such expenses are treated as production
overheads. When amount of such expenses is large, it may be spread over a period of time. If such
expenses are incurred due to faulty planning or some other abnormal factor, then they may be
charged to costing Profit and Loss Account.
 Bad debts:-Therefore bad debts should be treated in cost accounting in the same way as any other
selling and distribution cost. However extra ordinarily large bad debts should not be included in cost
accounts.
 Training expenses:-Training expenses of factory workers are treated as part of the cost of
production. The training expenses of office; sales or distribution workers should be treated as
office; sales or distribution overhead as the case may be. These expenses can be spread over
various departments of the concern on the basis of the number of workers on roll. Training expenses
would be abnormally high in the case of high labour turnover such expenses should be excluded from
costs and charged to the costing profit and loss account.
 Canteen expenses:-The subsidy provided or expenses borne by the firm in running the canteen
should be regarded as a production overhead. If the canteen is meant only for factory workers
therefore this expenses should be apportioned on the basis of the number of workers employed in
each department. If office workers also take advantage of the canteen facility, a suitable share of the
expenses should be treated as office overhead.
 Carriage and cartage expenses:-Transportation expenses related to direct material may be
included in the cost of direct material and those relating to indirect material (stores) may be
treated as factory overheads. Expenses related to the transportation of finished goods may be
treated as distribution overhead.
 Expenses for welfare activities:-All expenses incurred on the welfare activities of employees in a
company are part of general overheads. Such expenses should be apportioned between factory,
office, selling and distribution overheads on the basis of number of persons involved.
 Night shift allowance:-If this allowance is treated as part of direct wages, the jobs/production
carried at night will be costlier than jobs/production performed during the day. However, if additional
expenditure on night shift is incurred to meet some specific customer order, such expenditure may be
charged directly to the order concerned. If night shifts are run due to abnormal circumstances, the
additional expenditure should be charged to the costing profit and loss account.
 Research and Development Expenses:-If research is conducted in the methods of production, the
research expenses should be charged to the production overhead; while the expenditure becomes a
part of the administration overhead if research relates to administration. Similarly, market research
expenses are charged to the selling and distribution overhead.
 Development costs incurred in connection with a particular product should be charged directly
to that product. Such expenses are usually treated as “deferred revenue expenses,” and recovered as
a cost per unit of the product when production is fully established.
 General research expenses of a routine nature incurred on new or improved methods of
manufacture or the improvement of the existing products should be charged to the general
overhead.
Even in this case, if the amount involved is substantial it may be treated as a deferred revenue expenditure,
and spread over the period during which the benefit would accrue. Expenses on fundamental research, not
relating to any specific product, are treated as a part of the administration overhead. Where research
proves a failure, the cost associated with it should be excluded from costs and charged to the costing Profit
and Loss Account.

Activity Based Costing

Concise Notes
Meaning of Activity Based Costing:- Activity Based Costing is an accounting methodology that assigns
costs to activities rather than products or services. This enables resources & overhead costs to be more
accurately assigned to products & services that consume them. In other words ABC is a technique which
involves identification of cost with each cost driving activity and making it as the basis for apportionment
of costs over different cost objects/ jobs/ products/ customers or services.
Meaning of terms used in ABC:-
Activity – Activity refers to an event that incurs cost.
A Cost Object–It is an item for which cost measurement is required e.g. a product or a customer.

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A Cost Driver–It is a factor that causes a change in the cost of an activity. E.g. Production runs
Cost Pool-It represents a group of various individual cost items. It consists of costs that have same cause
effect relationship. E.g. Machine set-up.
There are two categories of cost driver:-
A Resource Cost Driver– It is a measure of the quantity of resources consumed by an activity. It is used to
assign the cost of a resource to an activity or cost pool.
An Activity Cost Driver – It is a measure of the frequency and intensity of demand, placed on activities by
cost objects. It is used to assign activity costs to cost objects.
Examples of Cost Drivers:-
Business Function Cost drivers
Research & Development • Number of research projects
• Personnel hours on a project
• Number of products in design
Design of products, services and procedures • Number of parts per product
• Number of engineering hours
• Number of service calls
Customer Service • Number of products serviced
• Hours spent on servicing products
• Number of advertisements
Marketing • Number of sales personnel
• Sales revenue

Distribution • Number of units distributed

• Number of customers

Example on Research & Development:-

Total expenditure on research & Development = ₹ 10,00,000; Number of projects = 10

Now cost per project = ₹ 1,00,000 ( ) or

E.g.2 Total number of personnel hours = 10,000; Number of hours in project A = 5,000; On B = 3,000 hours;
On C = 2,000 hours

Cost per hour = = ₹ 100 per hour

Cost apportioned to Project A = ₹ 100 per hour x 5,000 hours = ₹ 5,00,000

Cost apportioned to Project B = ₹ 100 per hour x 3,000 hours = ₹ 3,00,000
Cost apportioned to Project C = ₹ 100 per hour x 2,000 hours = ₹ 2,00,000
Example on Marketing Expenditure:-
Total marketing expenditure = ₹ 50,00,000; Number of product produced = 3 (A,B,C)
Number of units 10,000, 12,000 and 18,000 for product A, B, C respectively. Number of advertisement is 3, 2,
5 for product A,B,C respectively.

Cost per advertisement = ₹ 5,00,000( )

Cost of advertisement for per unit of A = = ₹ 150

Cost of advertisement for per unit of B = = ₹ 83.333

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Cost of advertisement for per unit of C = = ₹ 138.888

On the basis of sales personnel:-

Number of sales personnel = 150; Personnel involve in the ratio of 25:50:75 with respect to product A,B and
C.

Marketing cost per personnel = = ₹ 33,333.333

Marketing cost per unit for Product A = = ₹ 83.3333

Marketing cost per unit for Product B = = ₹ 138.8888

Marketing cost per unit for Product C = = ₹ 138.8888

On the basis of Sales Revenue:-

Selling price from Product A, B and C is ₹ 100, ₹ 120 and ₹ 180 per unit.
Sales revenue from A = ₹10,00,000 (10,000 units x ₹ 100 per unit)
Sales revenue from B = ₹14,40,000 (12,000 units x ₹ 120 per unit)
Sales revenue from C = ₹32,40,000 (18,000 units x ₹ 180 per unit)
Total sales revenue = ₹ 56,80,000

Marketing cost per unit for A = = ₹ 88.028

Marketing cost per unit for B = = ₹ 105.633

Marketing cost per unit for C = = ₹ 158.4507

Cost allocation under Traditional and Activity Based Costing System:-

In traditional absorption costing overheads are first related to cost centres (Production & Service
Centres) and then to cost objects, i.e., products. In ABC overheads are related to activities or grouped
into cost pools then they are related to the cost objects, e.g., products. The two processes are, therefore, very
similar, but the first stage is different as ABC uses activities instead of functional departments (cost centres).
Level of Activity in Activity Based Costing system:-
 Unit Level
 Batch Level
 Product Level
 Facilities Level
Stages in Activity Based costing:-
i. Identify the different activities within the organisation
ii. Relate the overheads to the activities, both support and primary, that caused them. This creates ‘cost
pools’ or ‘cost buckets’
iii. Support activities are then spread across the primary activities on some suitable base, which reflects
the use of the support activity.
iv. Determine the activity cost drivers that will be used to relate the overheads collected in the cost
pools to the cost objects/products.
v. Calculate activity cost driver rates for each activity.

Activity cost driver rate =

Example of cost drivers for different activity pools in a production department can be explained below:

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Activity Cost Pools Related Cost Drivers

Ordering and Receiving Materials cost Number of purchase orders
Setting up machines costs Number of set-ups
Machining costs Machine hours
Assembling costs Number of parts
Inspecting and testing costs Number of tests
Painting costs Number of parts
Supervising Costs Direct labour hours
Engineering Cost Number of Production orders

Examples for above cost drivers:-

Product manufactured/ Sold X ,Y, Z with quantity of 30,000 units, 20,000 units,8,000 units respectively.
Number of orders receipts is 15, 35, 220 respectively.
1. Material receiving cost = ₹ 4,35,000; Total number of receipts =15 + 35 + 220 = 270

Receiving cost per order = = ₹ 1611.1111

For product X = = ₹0.8055 per unit

For product Y = = ₹2.8194 per unit

For product Z = = ₹44.3055 per unit

2. Example on setting up cost:-

Setting cost = ₹ 30,000; Total number of production run = 30;

Setup cost per production run = = ₹ 1,000

Setup cost per unit for Product X = = ₹ 0.10

Setup cost per unit for Product Y = = ₹ 0.35

Setup cost per unit for Product Z = = ₹ 2.5

3. Example on Machine cost per hour:-

Machine cost = ₹ 7,60,000; Total number of Machine hour = 76,000; Labour hour per unit of X, Y, Z is 1.33, 2, 1
per hour respectively.

Machine cost per hour = = ₹ 10

Machine cost per unit for Product X = 10 x 1.33 = ₹ 13.33

Machine cost for Product Y = ₹ 10 x 1 = ₹ 10
Machine cost per unit for Product Z = ₹ 10 x 2 = ₹ 20
Advantages of Activity Based costing:-
i. More accurate costing of products/services.
ii. Overhead allocation is done on logical basis.
iii. It enables better pricing policies by supplying accurate cost information.
iv. Utilizes unit cost rather than just total cost
v. Help to identify non-value added activities which facilitates cost reduction.

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vi. It is very much helpful to organization with multiple product.

vii. It highlights problem areas which require attention of the management.
Limitation of Activity Based Costing:-
 It is more expensive particularly in comparison with Traditional costing system.
 It is not helpful to small Organization.
 It may not be applied to organization with very limited products.
 Selection of most suitable cost driver may not be useful.
Activity Based Management:-
The term Activity based management (ABM) is used to describe the cost management application of
Activity Based Costing (ABC). The use of ABC as a costing tool to manage costs at activity level is known
as Activity Based Cost Management (ABM). ABM is a discipline that focuses on the efficient and effective
management of activities as the route to continuously improving the value received by customers. It can be
used in cost reduction, Business process re-engineering, Benchmarking and performance
Measurement.
Activity Based Budgeting Analysis:-
Activity based budgeting analyse the resource input or cost for each activity. It provides a framework for
estimating the amount of resources required in accordance with the budgeted level of activity. It is a
planning and control system which seeks to support the objectives of continuous improvement. It means
planning and controlling the expected activities of the organization to derive a cost-effective budget that meet
forecast workload and agreed strategic goals. ABB is the reversing of the ABC process to produce financial
plans and budgets.
Key Elements of Activity Based Budgeting (ABB)
 Type of work to be done
 Quantity of work to be done
 Cost of work to be done
Few benefits of activity based budgeting are as follows:-
i. Activity Based Budgeting (ABB) can enhance accuracy of financial forecasts and increasing
management understanding.
ii. When automated, ABB can rapidly and accurately produce financial plans and models based on
varying levels of volume assumptions.
iii. ABB eliminates much of the needless rework created by traditional budgeting techniques.

Cost Sheet
Concise Notes
Meaning of Cost Sheet:-
A Cost Sheet or Cost Statement is “a document which provides detailed cost information”. In a typical cost
sheet, cost information is presented on the basis of functional classification.
Functional classification of Element of cost:-
Under this classification, costs are divided according to the function for which they have been incurred. The
following are the classification of costs based on functions:
i. Direct Material Cost
ii. Direct Employee (labour) Cost
iii. Direct Expenses
iv. Production/ Manufacturing Overheads
v. Administration Overheads
vi. Selling Overheads
vii. Distribution Overheads
viii. Research and Development costs etc.
The costs as classified on the basis of functions are grouped into the following cost heads in a cost sheet:
i. Prime Cost
ii. Cost of Production
iii. Cost of Goods Sold

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iv. Cost of Sales

Format of Cost sheet
Particulars Total Cost

Direct material Consumed:

Opening Stock xxx
Add: purchases xxx
Less: Closing Stock xxx xxxx
Direct Wages xxxx
Prime Cost xxxx
Factory overheads* xxxx
Gross Factory/Works Cost xxxx
Add: Opening WIP xxxx
Less: Closing WIP xxxx
Net Factory/Works Cost xxxx
Add: Quality Control cost
Add: Research & Development Cost (Process Related)
Add: Administrative Overheads related with production
Add: Packing Cost (Primary packing)
Less: Sale of scrap/Credit from recoveries(miscellaneous income) xxxx
Cost of Production xxxx
Add: Opening Stock of Finish Goods xxxx
less: Closing Stock of Finish Goods xxxx
Cost of Goods Sold xxxx
Add: Office and Administration Expenses xxxx
Add: Selling & Distribution Overheads xxxx
Cost of Sales xxxx
Profit xxxx
Sales xxxx

*Factory overheads are also known as works/Production/Manufacturing overheads. It is a form of indirect

expense for example Consumable stores and spares, Depreciation of plant and machinery, factory building
etc., Lease rent of production assets, Repair and maintenance of plant and machinery, factory building etc.,
Indirect employees cost related with production activities, Drawing and Designing department cost.,
Insurance of plant and machinery, factory building; stock of raw material & WIP etc., Amortized cost of jigs,
fixtures, tooling etc., Service department cost such as Tool Room, Engineering & Maintenance, Pollution
Control etc.
Advantages of Cost sheet or Cost Statements:-
i. It provides the total cost figure as well as cost per unit of production.
ii. It helps in cost comparison.
iii. It facilitates the preparation of cost estimates required for submitting tenders.
iv. It provides sufficient help in arriving at the figure of selling price.
v. It facilitates cost control by disclosing operational efficiency.
Point to be remember:-
1. In case in the question we are required to prepare the cost sheet and information regarding the value
of material purchased, Prime cost, Gross factory cost, Net Factory cost and cost of production is
missing and cost of goods sold is given than we need to let the value of purchase be ‘x’ and solve the
question by framing the equation.
2. General administrative overheads are added in the cost of goods sold. Examples are salary of
accountants, directors, Rent, Insurance, lighting of office building. Administration overheads related
to the production activity will be added in the net-works cost. If question is silent about the

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administration overheads than we will considered it as general and it will be added in the cost
of goods sold.

Cost Accounting System

Concise Notes
To operate business operations efficiently and successfully, it is necessary to make use of an appropriate
accounting system. Such a system should state in clear terms whether cost and financial transactions should
be integrated or kept separately (Non-integrated).
Meaning of Non-Integrated Accounting System:-
It is a system of accounting under which separate ledgers are maintained for cost and financial accounts by
Accountants. This system is also referred to as cost ledger accounting system. Non-Integrated Accounting
Systems contain fewer accounts when compared with financial accounting because of the exclusion of
purchases, expenses and also Balance Sheet items like fixed assets, debtors and creditors. Items of
accounts which are excluded are represented by an account known as Cost ledger control account.
Integrated Accounting System
Integrated Accounts is the name given to a system of accounting, whereby cost and financial accounts are
kept in the same set of books. Obviously, then there will be no separate sets of books for Costing and
Financial records. Integrated accounts provide or meet out fully the information requirement for Costing as
well as for Financial Accounts. Integrated accounts provide relevant information which is necessary for
preparing profit and loss account and the balance sheets as per the requirement of law and also helps in
exercising effective control over the liabilities and assets of its business.
Advantageous of integrated Accounting System:-
 No need for reconciliation
 Less efforts
 Less time consuming
 Economical Process
Features of Non-integrated Accounting System
 Complete analysis of cost and sales are kept.
 Complete details of all payments in cash are kept
 Complete details of all assets and liabilities are kept and this system does not use a notional account
to represent all impersonal accounts
In integrated system, all accounts necessary for showing classification of cost will be used but the cost
ledger control account of non-integrated accounting is replaced by use of following accounts:
 Bank account
 Receivables (Debtors) account
 Payables (Creditors) account
 Provision for depreciation account
 Fixed assets account
 Share capital account
Reconciliation of cost and financial accounts
When the cost and financial accounts are kept separately, it is imperative that those should be reconciled,
otherwise the cost accounts would not be reliable. It is necessary to remember that a reconciliation of the
two sets of accounts only can be made if both the sets contain sufficient details as would enable the
causes of differences to be located. It is, therefore, important that in the financial accounts, the expenses
should be analysed in the same way as in the cost accounts.
There are three steps involved in the procedure for the reconciliation:-
1. Ascertainment of profit as per financial accounts
2. Ascertainment of profit as per cost accounts
3. Reconciliation of both the profits (similar to the bank reconciliation statement).
Circumstances where reconciliation statement can be avoided:

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When the Cost and Financial Accounts are integrated - there is no need to have a separate reconciliation
statement between the two sets of accounts. Integration means that the same set of accounts fulfill the
requirement of both i.e., Cost and Financial Accounts.
Format of Reconciliation Statement:-
Particulars Amount (₹)
Profit as per Cost Accounts xxx
Add: Expenses over absorbed in cost sheet xxx
Less: Expenses under absorbed in cost sheet xxx
Profit as per Financial Accounts xxx

Causes of Difference in Financial & Cost Accounts:-

1. Items included in Financial Accounts only-
Purely Financial Expenses:-
i. Interest on loans or bank mortgages.
ii. Expenses and discounts on issue of shares, debentures etc.
iii. Other capital losses i.e., loss by fire not covered by insurance etc.
iv. Losses on the sales of fixed assets and investments
v. Goodwill written off
vi. Preliminary expenses written off
vii. Income tax, donations, subscriptions
viii. Expenses of the company’s share transfer office, if any.
Purely Financial Income:-
i. Interest received on bank deposits, loans and investments
ii. Dividends received
iii. Profits on the sale of fixed assets and investments
iv. Transfer fee received.
v. Rent receivables
2. Item included in Cost Accounts only (notional expenses):-
i. Charges in lieu of rent where premises are owned
ii. Interest on capital at notional figure though not incurred
iii. Salary for the proprietor at notional figure though not incurred
iv. Notional Depreciation on the assets fully depreciated for which book value is nil.
3. Items whose treatment is different in the two sets of accounts: For example, LIFO method is not
allowed for inventory valuation in India as per the Accounting Standard 2 issued by the Council of the ICAI.
However, this method may be adopted for cost accounts as it is more suitable for arriving at costs which shall
be used as a base for deciding selling prices. Similarly cost accounting may use a different method of
depreciation than what is allowed under financial accounting.
4. Varying basis of valuation: It is well known that in financial accounts stock are valued either at cost or
market price, whichever is lower. But in Cost Accounts, stocks are only valued at cost.
Memorandum Reconciliation Account:-In this account, the items charged in one set of accounts but not in
the other or those charged in excess as compared to that in the other are collected and by adding or
subtracting them from the balance of the amount of profit shown by one of the accounts, shown by the other
can be reached. The procedure is similar to the one followed for reconciling the balance with a bank that
shown by the cash book or the ledger.
Format of different accounts to be maintained in Non-Integrated Accounting system:-

Dr. Material cost control A/c Cr. Dr. Wages control A/c Cr.
Particulars ₹ Particulars ₹
Particulars ₹ Particulars ₹
To General ledger By WIP Control A/c (Direct)
To Balance b/d xx By WIP control A/c xx control A/c (Direct &
(Direct mat. issued) indirect wages paid) xx xx
To General led. control xx By Manu. Oh. control xx By Manufacturing overhead
A/c (in case of integrated A/c (Indirect control A/c (Indirect wages
a/c it will be either cash material issued) related to admini. & selling &
bank or supplier A/c) dist. control A/c xx
xx xx xx xx
Abnormal loss if any will be transferred to costing P&L account. Material Wages related to abnormal idle time is transferred to costing profit and
cost control account is also known as store ledger control account. loss account.
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Dr. Manufacturing overhead control A/c Cr.

Particulars ₹ Particulars ₹ Dr. WIP Control A/c Cr.
To Material Control A/c By WIP Control A/c Particulars ₹ Particulars ₹
(Posting) xx To Balance b/d xx By Finished Goods A/c xx
To Wages control A/c By Overhead Adjus. To Material Control A/c By Balance c/d
(Posting) A/c* (Diff. b/w (Posting) xx xx
overhead incurred & To wages control A/c
xx overhead absorbed) xx (Posting) xx xx
To Gen. Led. Control To Manufacturing Overhead
A/c (other overhead A/c (Posting) xx xx
paid) xx xx
xx xx
To Overhead
Adjustment A/c* Dr. Finished goods control A/c Cr.
xx xx
*Only one will appear
Particulars ₹ Particulars ₹
To Balance b/d By Cost of sales A/c
xx xx
To WIP Control A/c By Balance c/d
Dr. Administrative overheads control A/c Cr. xx xx
To Administration
Particulars ₹ Particulars ₹ overhead A/c xx
To Manufacturing By Finished goods
Control A/c (Posting) xx control A/c** xx xx xx
To Wages Control A/c By Overhead adjust.
(Posting) A/c* (diff. b/w
Dr. Selling & Distribution Overhead control A/c Cr.
overhead incurred &
xx overhead absorbed) xx Particulars ₹ Particulars ₹
To General ledger To Cost ledger Control By cost of sales A/c
Control A/c (other A/c (incurred) xx xx
overheads paid) xx To Overhead By Overhead adjust. A/c*
To overhead adjustment A/c* xx (under/over recovery) xx
adjustment A/c* xx xx xx
*Only one will appear
*Only one will appear xx xx
**Overhead recovered. If it is not related to production
transferred to cost of sales account.
Dr. Costing P&L A/c Cr.
Dr. Cost of Sales A/c Cr.
Particulars ₹ Particulars ₹
Particulars (₹) Particulars (₹) To Cost of sales A/c By Sales A/c
xx xx
To Finished goods By Costing P&L A/c To Abnormal loss A/c By Overhead adjustment A/c*
Control A/c xx xx xx xx
To Administrative To Overhead
overhead control A/c* xx xx adjustment A/c* xx
To Selling & To cost of ledger
Distribution overhead control A/c (Profit) xx
Control A/c xx xx
xx xx
xx xx *Only one will appear

Unit and Batch costing

Concise Notes
Meaning of Unit Costing:-
Unit costing is a method of costing, used where the output produced is identical and each unit of output
requires identical cost. Unit costing is synonymously known as single or output costing but these are sub-
division of unit costing method. Under this method costs are collected and analysed element wise and then
total cost per unit is ascertained by dividing the total cost with number of units produced. In the form of
formula:-

Cost per unit =

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This method of costing is application in industries like paper, cement, steel works, mining, breweries etc.
These types of industries produce identical products and therefore have identical costs.
Cost collection Procedure in unit costing:-
The cost for production of output is collected element wise and posted in the cost accounting system for cost
ascertainment. The element-wise collection is done as below:
Collection of Materials Cost
Cost of materials issued for production are collected from Material Requisition notes and accumulated for a
certain period or volume of activity. The cost of material so accumulated is posted in cost accounting system.
Through the cost accounting system cost sheet for the period or activity is prepared to know cost for the
period element-wise and functions-wise
Collection of Employees (labour) Cost
All direct employee (labour) cost is collected from job time cards or sheets and accumulated for a certain
period or volume of activity. The time booked or recorded in the job time and idle time cards is valued at
appropriate rates and entered in the cost accounting system.
Collection of Overheads
Overheads are collected under suitable standing orders numbers, and selling and distribution overheads
against cost accounts numbers. Total overhead expenses so collected are apportioned to service and
production departments on some suitable basis. The expenses of service departments are finally transferred
to production departments. The total overhead of production departments is then applied to products on
some realistic basis, e.g. machine hour; labour hour; percentage of direct wages; percentage of direct
materials; etc.
Treatment of spoiled and defective work:-
Loss due to Normal reason:-If the actual loss is within the limit of normal loss then the cost of rectification
and loss will be charged to the entire output. If the number of defective units substantially exceeds the normal
limits, the cost of rectification and loss will be transferred to costing P&L account.
Loss due to abnormal reason:-Cost of rectification and loss is treated as abnormal cost and the cost of
rectification or loss is written off as loss in Costing Profit and Loss Account.
Batch Costing
Meaning:-Batch Costing is a type of specific order costing where articles are manufactured in predetermined
lots, known as batch. Under this costing method the cost object for cost determination is a batch for
production rather output as seen in unit costing method.
Costing procedure in Batch Costing:-
Material cost for the batch is arrived at on the basis of material requisitions for the batch and labour cost is
arrived at by multiplying the time spent on the batch by direct workers as ascertained from time cards or Job
Tickets. Overheads are absorbed on some suitable basis like machine hours, direct labour hours etc.
Economic Batch Quantity:-
Economic batch Quantity is the quantity of a unit to be produced in the Batch so that the cost of production of
a batch will be minimize. It helps in determining the least production cost for a batch. Primarily the total
production cost under Batch production comprises two main costs namely:-
i. Machine Set Up Costs and
ii. Inventory holding costs.
If the size is higher, the set up cost may decline due to lesser set ups required but units in inventory will go up
leading to higher holding costs. If the lot size is lower, lower inventory holding costs are accomplished but
only with higher set up costs. Economic Batch quantity is the size of a batch where total cost of set-up and
holding costs are at minimum.
The mathematical formula usually used for its determination is as follows:
√
Economic Batch Quantity =

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Where, D = Annual demand for the product S = Setting up cost per batch C = Carrying cost per unit per annum
E.g. Annual Demand in market = 8,00,00,000 units; Share in Market = 1.15%; Inventory holding cost per unit
per month = 1.50; Setup cost per run = 3,500. Find Economic Batch Quantity.
A = 1.15% of 8,00,00,000 = 9,20,000 units; S = ₹ 3500; C = ₹ 1.5 x 12 months = ₹ 18

=√ = 18,915 units; Economic batch quantity = 18.915 units

Contract Costing
Concise Notes
Meaning of Contract costing
Contract costing is a form of specific order costing where job undertaken is relatively large and normally
takes period longer than a year to complete. Contract costing is usually adopted by the contractors engaged in
any type of contracts like construction of building, road, bridge, erection of tower, setting up of plant etc.
There are two types of contract first is Fixed Price Contract (with or without escalation clause) and second
is Cost Plus Contract.
Fixed Price Contract is a contract in which the price charged by the contractor is fixed at the time of entering
into agreement.
Cost- plus contract is a contract where the value of the contract is determined by adding an agreed
percentage of profit to the total cost. These types of contracts are entered into when it is not possible to
estimate the contract cost with reasonable accuracy due to unstable condition of factors that affect the cost of
material, employees, etc.
Escalation clause is a clause written in the agreement (contract) between the contractor and contractee
which states that in case of increase in the prices of materials, wages or other supplies beyond a certain level
the contract price will be increased by an agreed amount.
Dr. Contract Account Cr.
Particulars Amount (₹) Amount (₹) Particulars Amount (₹)
To Opening stock of material xxx By Material return to store xxx
To Material issued xxx By Material return to supplier xxx
To material purchased xxx By Plant at site (WDV) xxx
To Labour xxx By Plant return to store xxx
add: outstanding at end xxx By closing stock material xxx
less: outstanding at beginning xxx xxx By work cost xxx
To Architect's fees xxx
To Plant(cost) xxx
To Indirect Expenses xxx
To Share of general overheads xxx
To Fines and penalties paid xxx
xxx xxx

To Works cost xxx By Closing work in progress:-

To Opening Work in progress:- work certified xxx
work certified xxx work uncertified xxx
work uncertified xxx xxx
To Notional profits xxx xxx

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To Costing P&L Account xxx By Notional Profits xxx

To Reserve xxx
xxxx xxxx

Points need to be remembered:-

 Any loss of material due to theft or destruction etc. is transferred to the Costing Profit and Loss
Account and not in the contract account.
 If any stores items are used for manufacturing tools, the cost of such stores items are charged to the
work expenses account.
 If the contractee has supplied some materials without affecting the contract price, no accounting
entries will be made in the contract account, only a note may be given about it.
 Material cost, labour cost or any other expenses cost outstanding at end and prepaid at beginning
will be added and outstanding at beginning and prepaid at end will be subtracted.
Treatment of certain expenses:-
1. Direct expenses (if any) are directly charged to the concerned contract account.
2. Sub-contract costs are also debited to the Contract Account.
3. Wages paid to the direct workers are charged to the concerned contract directly. If an employee is
engaged concurrently in other contract also then the total wages paid is apportioned to the contacts
on some reasonable basis, usually on time basis.
4. Indirect expenses (such as expenses of engineers, surveyors, supervisors, corporate office etc.) may
be distributed over several contracts on certain reasonable basis as overheads.
5. The value of the Plant& Machinery in a contract may be either debited to contract account and the
written down value thereof at the end of the year entered on the credit side for closing the
contract account, or only a charge (depreciation) for use of the plant may be debited to the
contract account.
6. Any expense which is not related in any form whether directly or indirectly to the contract shall
not be form part of contract cost/account. E.g. land purchased to open office than purchase price,
brokerage, registration fees etc.
7. Site office expenses debited to the concerned contract account.
Meaning of Certain terms:-
Work-in-Progress (WIP): Work-in-progress is contract which is not complete at the reporting date. It
consist the following:-
i. The cost of work completed, both certified and uncertified;
ii. The cost of work not yet completed; and
iii. The amount of estimated/ notional profit.
WIP can be classified under two heads viz., work certified and work uncertified. The completion of work is
carried out by an expert (it may be any professional like surveyor, architect, engineer etc.).
Progress Payment: A Contractor gets payments for work done on a contract based on work completion.
Progress payment = Value of work certified – Retention money – Payment to date
Retention Money: In a contract, a contractee generally keeps some amount payable to contractor with
himself as security deposit to ensure that the work carried out by the contractor is as per the plan and
specifications; it is monitored periodically by the contractee.
Retention Money = Value of work certified – Payment actually made/ cash paid
Notional Profit: It represents the difference between the value of work certified and cost of work
certified.
Notional profit = Value of work certified – (Cost of work to date – Cost of work not yet certified)

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Estimated Profit: It is the excess of the contract price over the estimated total cost of the contract.
Certain formulas used in contract costing
Value of Work Certified = Value of Contract × Percentage of completion or Work certified (%)
Cost of Work Certified = Cost of work to date – (Cost of work uncertified + Material in hand + Plant at site)

Percentage of completion of work = x 100

Cash received = Value of work certified – Retention money

Amount to be transferred to Costing Profit & Loss Account:-
When work certified is 25% or more but less than 50% of the contract price

Profit transferred = × Notional profit ×

When work certified is 50% or more but less than 90% of the contract price

Profit transferred = × Notional profit ×

When the contract is almost complete i.e. 90% or more of the contract price

Profit transferred = Estimated Profit ×

Or, = Estimated Profit ×

Or, = Estimated Profit ×

Or, = Notional Profit ×

Or, = Estimated profit × ×

Note:-For computing the escalation claim where standard and actual rates are given we need to subtract actual
rate with standard.
Example:-Cash received = ₹ 72,000; Notional profit = ₹ 12,200; Estimated profit = ₹ 80,000;
Work certified = ₹ 1,00,000; Contract price = ₹ 2,00,000; Cost of work to date = ₹ 1,05,000
Work certified is 25% or more but less than 50% of contract price

Profit transferred to costing P&L A/c = x 12,200 x = ₹ 2,928

Work certified is 50% or more but less than 90% of contract price

Profit transferred to costing P&L A/c = x 12,200 x = ₹ 5,856

Work certified is 90% or more of contract price

Profit transferred to costing P&L A/c = ₹ 80,000 x = ₹ 40,000

Or
Profit transferred to costing P&L A/c = ₹ 80,000 x = ₹ 28,800
Or
Profit transferred to costing P&L A/c = ₹ 80,000 x = ₹ 70,000

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Or
Profit transferred to costing P&L A/c = ₹ 12,200 x = ₹ 6,100
Or
Profit transferred to costing P&L A/c = ₹ 80,000 x x = ₹ 50,400

Process Costing
Concise Notes
Meaning of Process Costing:-Process Costing is a method of costing used in industries where the material
has to pass through two or more processes for being converted into a final product. A separate account
for each process is opened and all expenditure pertaining to a process is charged to that process account.
Examples of industries where it is used steel, paper, medicines, soaps, chemicals, rubber, vegetable oil, paints,
varnish etc. The cost of each process comprises the cost of:-
 Material
 Labour
 Direct Expenses
 Overheads
Dr. Format of Process Account Cr.
Particulars Units Amount (₹) Particulars units Amount (₹)
By Transfer to next
To Opening stock - - Process/Finished Goods - -
To Material introduced - - By Closing stock - -
To wages - - By Normal loss - -
To Overheads - - By Abnormal loss A/c* - -
To Abnormal gain A/c* - - - -
- - - -
*Only one will be appear
Cost per unit is always calculated on the basis of Expected output.
Formula of expected output:-
Expected Output = Input – Normal Loss; or
Expected Output = Output + Abnormal loss; or
Expected Output = output – Abnormal gain

Cost per unit =

Meaning and Treatment of Normal loss, Abnormal loss and Abnormal gain:-
Normal loss: It is defined as the loss of material which is inherent in the nature of work. It is
unavoidable because of nature of the material or the process. It also includes units withdrawn from the
process for test or sampling.
Treatment: The cost of normal process loss in practice is absorbed by good/units produced under the
process. The amount realised by the sale of normal process loss units should be credited to the process
account.
Abnormal Loss: It is defined as the loss in excess of the pre-determined loss (Normal process loss). This
type of loss may occur due to the carelessness of workers, a bad plant design or operation, sabotage etc. It
can be kept under control by taking suitable measures.
Actual output ˂ Input – Normal loss = Abnormal Loss

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E.g. Raw material introduced = 10,000kg; Normal loss = 5%; Actual output = 9200kg; Expected Output =
10,000kg – 5%of 10,000kg = 9,500kg; Abnormal loss = 9500kg – 9200kg = 300kg
Treatment: The cost of an abnormal process loss unit is equal to the cost of a good unit. The cost of abnormal
process loss is credited to the process account from which it arises. Cost of abnormal process loss is not
treated as a part of the cost of the product. In fact, the total cost of abnormal process loss is debited to
costing profit and loss account after adjusting normal loss.
Dr. Abnormal loss A/c Cr.
Particulars units Amount(₹) Particulars Units Amount(₹)
To Process A/c(t/f) xxx xxx By Cash account (realization) xxx xxx
By Costing profit and loss A/c (loss) - xxx
xxx xxx xxx xxx

Abnormal Gain: Loss under a process is less than the anticipated normal figure. This arises due to over-
estimation of process loss, improvements in work efficiency of workers, use of better technology in
production etc. It can be calculated by using following formula:-
Actual output ˃ Input – Normal loss = Abnormal gain
E.g. Raw material introduced = 10,000kg; Normal loss = 5%; Actual output = 9600kg; Expected Output =
10,000kg – 5%of 10,000kg = 9,500kg; Abnormal gain = 9600kg – 9500kg = 100kg
Treatment: The process account under which abnormal gain arises is debited with the abnormal gain and
credited to abnormal gain account which will be closed by transferring to the Costing Profit and Loss
account. The cost of abnormal gain is computed on the basis of normal production.
Dr. Abnormal Gain A/c Cr.
Particulars Units (₹) Particulars Units (₹)
To Normal wastage() xxx Xxx By Process A/c(transfer) xxx xxx
To Costing profit & loss account(t/f) Xxx
xxx Xxx xxx xxx

Valuation of Closing Work-In-Progress (WIP):

For computing the value of closing work in progress we need prepare the statement of equivalent production.
There are two methods for computing the same first in first out (FIFO) and weighted average method.
Equivalent units or equivalent production units means converting the incomplete production units into
their equivalent complete units. Under each process, an estimate is made of the percentage completion of
work-in-process with regard to different elements of costs.
Format of statement of equivalent production is follows:-
Material 1 Wages Overheads
Input Particulars Output % unit % unit % unit
Opening work in progress - - - - - - -
Input - - - - - - -
Finished output - - - - - - -
Normal Loss - - - - - - -
Abnormal loss/gain - - - - - - -
Closing Work in progress - - - - - - -
0 0 0 0 0

Points need to remember while making statement of equivalent production:-

 If percentage of completion of abnormal loss is not given than it will be treated as 100% with
respect to each element of cost.
 For normal loss, no equivalent unit is calculated.
 Abnormal Gain is treated as 100% complete in respect of all cost elements irrespective of percentage
of completion. It is subtracted in the statement.
 Under the weighted average method percentage of completion of opening work in progress is
taken as 100% but in case of FIFO method percentage of incompletion or percentage of work
done in current year is considered.
 In case output is not given in the question then we will assume actual output same as expected
output i.e.(Input – Normal loss)

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 % of completion for opening WIP means % already last month | Balance

स month |
 % of completion for closing WIP means स month input |
 स स Opening WIP finished goods convert | (Firstly Opening WIP will be converted
into finished goods)
Inter process Profits
If goods are transferred from one process to another process not on cost but by adding some profits. Such
profit are termed as inter process profits.
Advantages:
i. Comparison between the cost of output and its market price at the stage of completion is facilitated.
ii. Each process is made to stand by itself as to the profitability.
Disadvantages:
i. The use of inter-process profits involves complication.
ii. The system shows profits which are not realised because of stock not sold out.
Important Note:-
For computing the stock reserve or part of profit included in the closing stock we need to find out the
ratio between the material transferred from the previous process account and the cost incurred in the
existing process account.
Operation Costing
This product costing system is used when an entity produces more than one variant of final product using
different materials but with similar conversion activities. It is also known as Hybrid product costing
system. In this system materials costs are accumulated by job order or batch wise but conversion costs i.e.
labour and overheads costs are accumulated by department, and process costing methods are used to assign
these costs to products. Under operation costing, conversion costs are applied to products using a
predetermined application rate.
For example, a company is manufacturing two grades of products, Product- Deluxe and Product- Regular.
Both the products pass through a similar production process but require different quality and quantities of
raw materials. The cost of raw material is accumulated on the basis of job or batches or units of two variants
of products. But the costs for the conversion activities need not to be identified with the product variants as
both the products required similar activities for conversion. Hence, conversion activity costs are accumulated
on the basis of departments or processes only. Example of industries where this system is used is ready made
garments, Shoe making, jewelry etc.

Joint & By-Product costing

Concise Notes
Joint Products - When two or more products of equal importance produced, simultaneously from the same
process, with each having a significant relative sale value are known as joint products. For example, in the oil
industry, gasoline, fuel oil, lubricants, paraffin, coal tar, asphalt and kerosene are all produced from crude
petroleum. These are known as joint products.
By-Products - By-Products emerge as a result of processing operation of another product or they are
produced from the scrap or waste of materials of a process. In other words a by-product is a secondary or
subsidiary product which emanates as a result of manufacture of the main product.
The point at which they are separated from the main product or products is known as split-off point. The
expenses of processing are joint till the split –off point. Examples of by-products are molasses in the
manufacture of sugar, tar, ammonia and benzole obtained on carbonisation of coal and glycerin obtained in
the manufacture of soap.
Methods of Allocation of Joint cost to Joint Products:-
i. Physical Units Method/Unit Method
ii. Sale value at the point of separation
iii. Net Realisable Value at split-off point
iv. Sale value after further processing Important

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v. Contribution margin method

vi. Average unit cost method
vii. Using Technical Estimates
1. Physical Quantity Method:-The basis used for apportioning joint cost over the joint products is the
physical volume of material present in the joint products at the point of separation. Any loss arises during
the joint production process is also apportioned over the products on the same basis. This method cannot be
applied if the physical units of the two joint products are different. The main defect of this method is that it
gives equal importance and value to all the joint products.
2. Sale value at the point of Separation point:-Under this method joint cost is apportioned between the
joint products on the basis of sales value at the point of separation.
3. Net Realisable value at split-off point:-In this method of joint cost apportionment the followings are
deducted from the sales value of joint products at final stage i.e. after processing:
 Estimated profit margins,
 Selling and distribution expenses, if any, and
 Post-split off costs.
4. Sale value after further Processing:-Under this method joint cost is apportioned at the sales value after
further processing or in other words sales value of finished goods.
5. Contribution margin Method:-According to this method, joint costs are segregated into two parts -
variable and fixed. The variable costs are apportioned over the joint products on the basis of units
produced (average method) or physical quantities. In case the products are further processed after the
point of separation, then all variable cost incurred be added to the variable costs determined earlier. In this
way total variable cost is arrived which is deducted from their respective sales values to ascertain their
contribution. The fixed costs are then apportioned over the joint products on the basis of the contribution
ratios.
6. Average unit cost Method:-Under this method, total process cost (upto the point of separation) is divided
by total units of joint products produced. On division average cost per unit of production is obtained.

Average cost per unit =

7. Using the technical Estimates:-This method uses technical estimates to apportion the joint costs over the
joint products. This method is used when the result obtained by the above methods does not match with the
resources consumed by joint products or the realisable values of the joint products are not readily available.
Example covering the all the methods:-
E.g. Raw material processed = 1100 kg; Production of X = 400kg; Production of Y = 250kg; Production of Z =
350kg Cost of processing the raw material = ₹ 22,000(joint cost), Market price at split off point is ₹ 33,₹ 44, ₹
66 per kg respectively. Further processing cost is ₹ 6,000 for X, ₹ 4,500 for Y, and ₹ 7,000 for Z. Market value
after further processing ₹ 50, ₹60,₹70.
1. Allocation of joint cost using physical quantity method:-
Product X Y Z
Quantity Produced 400kg 250kg 350kg
Ratio 8 5 7

Cost allocation Product X = ₹ 22,000 x 8/20 = ₹ 8,800

Cost allocation Product Y = ₹ 22,000 x 5/20 = ₹ 5,500
Cost allocation Product Z = ₹ 22,000 x 7/20 = ₹ 7,700
2. Allocation of joint cost at sale value at split off point:-
Output Total value
Product (kg) Market price (₹) Ratio Cost allocation (₹)
X 400 33 13,200 132 22,000 x 132/473 = 6,140
Y 250 44 11,000 110 22,000 x 110/473 = 5,116
Z 350 66 23,100 231 22,000 x 231/473 = 10,744

3. Allocation of joint cost using NRV method:-

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Total Market value Further processing Cost NRV Ratio Cost allocation (₹)
13,200 6,000 7,200 72 22,000 x 72/298 = 5,325
11,000 4,500 6,500 65 22,000 x 65/298 = 4,798
23,100 7,000 16,100 161 22,000 x 161/298 = 11,886

4. Allocation of joint cost using market value after further processing method:-
Product Output (kg) Market price Total Market value Ratio Cost allocation (₹)
X 400 50 20,000 200 22,000 x 200/595 = 7,395
Y 250 60 15,000 150 22,000 x 150/595 = 5,540
Z 350 70 24,500 245 22,000 x 245/595 = 9,059

5. Allocation of joint cost using Contribution margin method:-

Joint variable cost per unit = = ₹ 22

Total variable cost for product X = ₹ 22 x 400 kg + 6,000 = ₹ 14,800

Total variable cost for product Y = ₹ 22 x 250 kg + 4,500 = ₹ 10,000
Total variable cost for product Z = ₹ 22 x 350 kg + 7,000 = ₹ 14,700
Contribution = Sale value after further processing – Total variable cost
Contribution of X = 400kg x ₹ 50 - ₹ 14,800 = ₹ 5,200
Contribution of Y = 400kg x ₹ 50 - ₹ 10,000 = ₹ 5,000
Contribution of Z =400kg x ₹ 50 - ₹ 14,700 = ₹ 9,800
Contribution margin Ratio = 52:50:98
Cost allocation Product X = ₹ 22,000 x 52/200 = ₹ 5,720
Cost allocation Product Y = ₹ 22,000 x 50/200 = ₹ 5,500
Cost allocation Product Z = ₹ 22,000 x 98/200 = ₹ 10,780
6. Allocation of joint cost using Average cost method:-

Average cost per unit =

Average cost per unit = = ₹ 22 per unit

Cost allocation Product X = 400 kg x ₹ 22 = ₹ 8,800

Cost allocation Product Y = 250 kg x ₹ 22 = ₹ 5,500
Cost allocation Product Z = 350 kg x ₹ 22 = ₹ 7,700

Operating Costing
Concise Notes
Meaning of Service or Operating Costing
Service costing is the technique or method of computing the cost involved in the service sector. In other
words in service costing we find out the cost per unit of various service sectors like transportation, hotels,

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financial services & banking, insurance, electricity generation, transmission and distribution, Hospitals,
Canteen & Restaurants, Hotels & Lodges, Educational institutes, Financial institutions, Insurance, Information
Technology (IT) & Information Technology Enabled Services (ITES) etc. Service costing is also known as
operating costing.
Application of service costing:-
Internal:-The service costing is required for in-house services provided by a service cost centre to other
responsibility centres as support services. Examples of support services are Canteen and hospital for staff,
Boiler house for supplying steam to production departments, Captive Power generation unit research &
development, quality assurance, laboratory etc.
External:-When services are offered to outside customers as a profit centre in consonance with
organisational objectives as an output like goods or passenger transport service provided by a transporter,
hospitality services provided by a hotel, provision of services by financial institutions, insurance and IT
companies etc.
Examples of measuring factor of cost per unit in various industries:-
Service industry Unit of cost (examples)
Transport Services Passenger- km., (In public transportation)
Quintal- km., or Ton- km. (In goods carriage)
Electricity Supply service Kilowatt- hour (kWh)
Hospital Patient per day, room per day or per bed, per
operation etc.
Canteen Per item, per meal etc.
Cinema Per ticket.
Hotels Guest Days or Room Days
Bank or Financial Institutions Per transaction, per services (e.g. per letter of credit,
per application, per project etc.)
Educational Institutes Per course, per student, per batch, per lecture etc.
IT & ITES Cost per project, per module etc.
Insurance Per policy, Per claim, Per TPA etc.

Composite Cost Unit:

Sometime two measurement units are combined together to know the cost of service or operation. These are
called composite cost units. For example, a public transportation undertaking would measure the operating
cost per passenger per kilometre.
Composite unit may be computed in two ways.
 Absolute (Weighted Average) basis.
 Commercial (Simple Average) basis.
Example:-
5 tonnes 7 tonnes (5+2) 3 tonnes (7-4)
A 20km B 50km C 100km D

Loading = 2 tonnes unloading = 4 tonnes

Absolute tonne kilometer = 20km × 5 tonnes + 50km × 7 tonnes + 100km × 3 tonnes
Absolute tonne kilometer = 100 + 350 + 300 = 750 tonnes km
Commercial tonne kilometre = Average weight × Total distance

Average weight = = 5 tonnes

Total distance travelled = 20km + 50km + 100km = 170km

Commercial tonnes km = 5 tonnes x 170km = 850 tonnes km.

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Steps to solve questions:-

Step:-1 Make cost sheet of service provider for a specific period viz. a month, quarter or a year etc.
Step:-2 Measure ‘unit of cost’ e.g. Number of tickets expected to be sold in a time period, number of
passengers expected to be travelled in a time period.
Step:-3 Find out cost per unit & add profits to decide fixed amount to be charged.
Points need to remember while computing the Service costing:-
 Petrol/Diesel consumption, Expenditure on repair & maintenance etc. is computed on the basis of
distance travelled.
 Fare is computed on the basis of passenger kilometer or tonne kilometer.
 Depreciation, salary, rent, insurance premium road license etc. is computed on timely basis.
 Cost of engine oil is computed on the basis of distance travelled.
 In case where question required finding out the break-even point than first find contribution per
unit and totaling fixed cost and then divide the total fixed cost from contribution per unit.

Standard Costing
Concise Notes
Meaning of Standard cost:-Standard cost is defined in the CIMA Official Terminology as “'the planned unit
cost of the product, component or service produced in a period. The standard cost may be determined on a
number of bases. The main use of standard costs is in performance measurement, control, inventory
valuation and in the establishment of selling prices.” From the above definition Standard costs can be said as
 Planned cost
 Determined on a base or number of bases.
Meaning of Standard Costing:-
Standard costing is a method of costing which measure the performance or an activity by comparing actual
cost with standard cost, analyses the variances and reporting of variances for investigation.
Need of Standard Costing:-Apart from performance evaluation and cost control, standard costs are also
used to value inventory where actual figures are not reliably available and to determine selling prices
particularly while preparing quotations.
Standard costing system is widely accepted as it serves different needs of an organisation. The standard
costing is preferred for the following reasons:
The standard costing is preferred for the following reasons:-
 Prediction of future cost for decision making
 Provide target to be achieved
 Used in budgeting and performance evaluation
 Interim profit measurement and inventory valuation
Types of Standards:-
Ideal Standards:-These represent the level of performance attainable when prices for material and labour
are most favourable, when the highest output is achieved with the best equipment and layout and when the
maximum efficiency in utilisation of resources results in maximum output with minimum cost.
Normal Standards:-These are standards that may be achieved under normal operating conditions.
Basic or Bogey Standards:-These standards are used only when they are likely to remain constant or
unaltered over a long period.
Current Standards:-These standards reflect the management’s anticipation of what actual costs will be for
the current period.
The process of standard costing:-

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 Setting of Standards
 Ascertainment of actual costs
 Comparison of actual cost with standard cost
 Investigate the reasons for variances
 Disposition of variances
Setting up of Standard Cost:-
Generally, while setting standards, consideration is given to historical data, current production plan
and expected conditions of future. For the sake of detailed analysis and control standard cost is set for each
element of cost i.e. material, labour, variable overheads and fixed overheads.
Standards are set in both quantity (units or hours) and in cost (price or rate). It is thus measure in
quantities, hours and value of the factors of production. Standard costs are divided into three main cost
components:-
1. Direct Material Cost
2. Direct Employee (Labour) Cost and
3. Overheads (Fixed & Variable)
Meaning of variance:-A divergence from the predetermined rates, expressed ultimately in money value,
generally used in standard costing and budgetary control systems.
Types of variances:-
Controllable and un-controllable variances: Controllable variances are those which can be controlled
under the normal operating conditions if a responsibility centre takes preventive measures and acts
prudently. Uncontrollable variances are those which occurs due to conditions which are beyond the
control of a responsibility centre and cannot be controlled even though all preventive measures are in
place.
Favourable and Adverse variance:
Adverse Variance = Actual Cost > Standard Cost
Favourable Variance = Actual Cost < Standard Cost
Classification of variances:-
1. Material cost variance

Material Price Variance Material Usage variance

Material Mix variance Material Yield variance

2. Labour cost Variance:-

Labour Rate variance Labour Efficiency variance

Labour Mix variance Idle Time variance Labour yield variance

3. Overhead Cost variance

Variance overhead Cost variance Fixed Overhead Cost Variance

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Expenditure & Budget Variance Efficiency Variance

Expenditure & Budget Variance Volume variance

Efficiency Variance Capacity Variance Calendar variance

Computation of Variances:-
Material variance
Material cost variance is the difference between standard cost of materials used and the actual cost of
materials. Formula of this variance is as follows:-
Material cost variance = Standard cost – Actual Cost
Or
Material cost variance = Standard Quantity x Standard Price – Actual Quantity x Actual Price

Reasons for variance: Material cost variance arises mainly because of either difference in material price
from the standard price or difference in material consumption from standard consumption or both the
reasons. ( consumption वज़ स variance)
Material Price Variance:-It measures variance arises in the material cost due to difference in actual material
purchase price from standard material price. Formula of this variance is as follows:-
Material Price Variance = [Standard Cost of Actual Quantity* – Actual Cost]
*Here actual quantity means actual quantity of material purchased. If in the question material purchase is not
given, it is taken as equal to material consumed.
Or
Material Price Variance = Actual Quantity × {Standard Price – Actual Price}

Purchase department is responsible for this variance, because raw material is purchased at a price which is
more than standard price. Here price is paid for actual quantity therefore actual quantity is used to compute
the variance. (Purchase department | Price, actual quantity pay )
Material usage variance: It measures variance in material cost due to usage. Formula of this variance is as
follows:-
Material usage variance (MUV) = (Standard Quantity – Actual Quantity) x Standard Price
Or
MUV = Standard Cost of Standard Quantity for Actual Production – Standard Cost of Actual Quantity*
*Here actual quantity means actual quantity of material used.

Responsibility for material usage variance: Material usage is the responsibility of production
department and it is held responsible for adverse usage variance. (Usage production department
price , स standard price )
Reasons for variance: Actual material consumption may differ from the standard quantity either due to
difference in proportion used from standard proportion or due to difference in actual yield from standard
yield.

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Material usage variance is divided into two parts

(i) Material usage mix variance and
(ii) Material yield variance.

Material Mix Variance: Variance in material consumption may arise due to difference in proportion
actually used from the standard mix/ proportion. It only arises when two or more inputs are used to
produce a product. ( Ratio वज़ स स standard price ) Formula of this variance is as follows:-
Material Mix variance = Standard Price × {Actual Quantity – Actual Quantity in Standard ratio}
Or
Material Mix variance = [Standard Cost of Actual Quantity in Standard ratio – Standard Cost of Actual Quantity]
 It is assumed that no wrong usage of raw material.

Material Yield Variance: Variance in material consumption which arises due to wrong usage of quantity
of raw material. It may arise due to use of sub- standard quality of materials, inefficiency of workers or due
to wrong processing. ( quantity वज़ स:-use standard price)
While computing this variance it is assumed that material is used in correct ratio or no wrong ratio of
material is used. Formula of this variance is as follows:-
Material yield variance = (Standard Quantity – Revised standard Quantity) x Standard price
Verification of the formulae:
Material Cost Variance = Material Usage Variance + Material Price Variance*
*If material purchased quantity and material consumed quantity is same
Or,
Material Cost Variance = (Material Mix Variance + Material Revised usage Variance) + Material price variance
Labour Variance
Labour Cost variance = Actual cost – Standard Cost or
Labour Cost variance = Actual Hour x Actual Rate – Standard Hour x Standard Rate

Reasons for variance: Difference in labour cost arises either due to difference in the actual labour rate
from the standard rate or difference in numbers of hours worked from standard hours. (Rate hours
वज़ स variance).
Labour cost variance can be classified into two categories:-
1. Labour rate variance
2. Labour efficiency Variance
1. Labour rate variance: Labour rate variance arises due to difference in actual rate paid from standard rate.
It is very similar to material price variance. Formula of variance is as follows:-
Labour rate variance = (Standard rate – Actual rate) x Actual Hour

Responsibility for labour rate variance: Generally labour rates are influenced by the external factors
which are beyond the control of the organisation. However personnel manager is responsible for labour rate
negotiation (Rate वज़ स variance, use actual hours).
2. Labour Efficiency variance: It arises due to deviation in the working hours from the standard working
hours. Formula of variance is as follows:-
Labour Efficiency variance = (Standard hour – Actual hour) x Standard rate

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Responsibility for labour efficiency variance: Efficiency variance may arise due to ability of the workers,
inappropriate team of workers, inefficiency of production manager or foreman etc. However, production
manager or foreman can be held responsible for the adverse variance which otherwise can be controlled.
(Time/Hour वज़ स variance, use standard rate).
Labour efficiency variance is further divided into the following variances:
1. Labour Mix variance
2. Idle Time variance
3. Labour Yield variance

Labour mix variance:-Labour mix variance which arises due to change in the mix or combination of different
skill set i.e. number of skilled workers, semi-skilled workers and un-skilled workers. ( व Ratio वज़ स
hour and idle time impact ). Formula of labour mix variance is as follows:-
Labour mix variance = (Actual hours – Actual hours in standard ratio) x Standard rate
While computing the labour mix variance only ratio impact is considered and hours and idle time is not
considered.

Labour Idle time variance:-It is calculated for the idle hours. It is difference between paid and worked
hours. (Idle time वज़ स). It is calculated as below:
Labour idle time variance = (Actual hours – Actual hours worked) x Standard rate; or
Labour idle time variance = [Standard Rate per Hour × Actual Idle Hours]
Labour yield variance:-Labour efficiency variance which arises due to productivity of workers. Formula of
labour yield variance is as follows:-
Labour Yield Variance = (Standard Hour × Standard Rate) – (Revised Standard Hour × Standard Rate)
Verification of formulae:
Labour Cost Variance = Labour Rate Variance + Labour Efficiency Variance (if hours paid and hours worked is
same)
OR
Labour Cost Variance = Labour Rate Variance + Idle Time Variance + Labour Efficiency Variance
OR
Labour Efficiency Variance = Labour Mix Variance + Labour Yield Variance
Variable Overhead Variance
Variable overheads consist of variable expenses which vary with the level of production. If variable overhead
consist of indirect materials, then in this case it varies with the direct material used. On the other hand, if
variable overhead is depending on number of hours worked then in this case it will vary with labour
hour or machine hours. If nothing is mentioned specifically then we take labour hour as basis. Variable
overhead cost variance calculation is similar to labour cost variance.
V. overhead cost variance = Standard Variable Overheads for Production – Actual Variable Overheads
Variable overhead cost variance is divided into two parts:-
1. Variable Overhead Expenditure Variance and
2. Variable Overhead Efficiency Variance.
1. Variable overhead expenditure variance = Actual hours (Standard rate - Actual rate)
2. Variable overhead efficiency variance = Standard rate per hour (Standard Hours – Actual Hours)
Very important point while calculating the variable overhead variances:-

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 In case of variable overheads, Recovery rate is computed. I.e. Estimated variable overheads ÷ estimated
production.
 Variable overheads standards is revised on the basis of units produced is completely wrong thought
and if this thought is followed than question will get wrong .(Revision of standard units produced
basis )

 Variable overhead are linked with labour hours/Machine hours. Standard will be revised not on
the basis of units produced rather than on the basis of labour hours/Machine hours. (Revision of
standard labour hour or machine hour basis )
 Per unit variable overheads recovery rate is fixed but total recovery of variable overhead is not fixed, it
is dependent on production.
 Recovery rate x actual production = Total recovery
 Recovery of variable overheads is based on the level of output
E.g. Budgeted output = ₹ 30,000; Budgeted machine hours = 30,000; Budgeted variable overheads = ₹ 60,000;
Actual output = ₹ 32,500; Actual machine hours = 33,000; Actual variable overheads = ₹ 68,000

Solution: Recovery rate = ;= = ₹ 2 per unit

Variable overhead cost variance = Recovery v/s Actual

Variable overhead cost variance = 32,500 units x ₹ 2 per - ₹ 30,000 = ₹ 3,000(A)
Variable overhead expenditure variance:-

Revised standard = x 33,000 hours = ₹ 66,000

Variable overhead expenditure variance = ₹ 66,000 - ₹ 68,000 = ₹ 2,000(A)

Variable overhead efficiency variance = Actual recovery – Revised standard overheads
Variable overhead efficiency variance = 32,500units x ₹ 2 per unit – ₹66,000 = ₹1,000(A)
Fixed Overhead variance
Fixed Overhead Cost Variance: Fixed overhead cost variance is the difference between actual fixed
overhead and absorbed fixed overhead.
Fixed overhead cost variance = Actual fixed overheads – (Actual output x Recovery rate*)

*Recovery rate per unit =

*Recovery rate per hour =

Here recovery of fixed overheads and actual overhead incurred is compared and variance is computed
accordingly.
Fixed overhead variance is divided into two parts:-

(A) Fixed Overhead Expenditure Variance:-This is the difference between the actual fixed overhead
incurred and budgeted fixed overhead. ( वज़ स )
Fixed overhead expenditure variance = Budgeted Expenditure – Actual Expenditure

(B) Fixed Overhead Volume Variance: Variance in fixed overhead which arise due to the volume of
production is called fixed overhead volume variance. Here budgeted recovery with actual recovery is
compared. (Recovery वज़ स )
Fixed overhead volume variance = Budgeted output x recovery rate – Actual output x recovery rate

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Fixed overhead volume variance is further divided into the three variances:

(a) Fixed overhead Efficiency Variance:-This is the difference between fixed overhead absorbed and
standard fixed overhead. स capacity स व variance.

(b) Capacity Variance: This is the difference between standard fixed overhead and budgeted overhead.
स capacity variation स variance.
Based on output:-
= Expected output of number of days worked x (Capacity level – Actual level) x Recovery rate
Based on hours:-
= (Expected hours of number of days worked – Actual hours) x Recovery rate

(c) Calendar Variance: This variance arises due to difference in number of actual working days and the
standard working days. स variance. It is computed by using the following formula.

F.O. C. variance = x Number of days worked - Budgeted days of working)

Number of days worked > Budgeted days of working – Favourable

Number of days worked < Budgeted days of working – Adverse able
Verification of formulae:
F.O. Cost Variance = F.O. Expenditure Variance + F.O. Volume Variance
F.O. Volume Variance = Efficiency Variance + Capacity Variance + Calendar Variance
 E.g. Budgeted Fixed overheads = ₹ 10,000; Budgeted output = 1000 units; Actual overheads = 12,000; Actual
output = 800 units; Number of working days = 25; number of days worked = 24; capacity at which work is
done = 90%

Recovery rate = = = ₹ 10 per unit

Fixed overhead cost variance = 12,000 - ₹ 10 per unit x 800 units = 4,000(A)
Fixed overhead expenditure variance = ₹ 10,000 – 12,000 = 2,000(A)
Fixed overhead volume variance = Budgeted output x recovery rate – Actual output x Recovery rate
Fixed overhead volume variance = 1,000 units x ₹ 10 – 800 units x ₹ 10 = ₹ 2,000(A)

Fixed overhead efficiency variance = ( x 24 days x 90%) – 800 units x ₹ 10 per hour = ₹ 640(A)

Fixed overhead capacity variance = ( x 24 days) x (100% - 90%) x ₹ 10 per unit = ₹ 960(A)

Fixed overhead calendar variance = ( )(25days - 24 days) x ₹ 10 per unit = ₹ 400(A)

Marginal Costing
Concise Notes
Marginal costing meaning:- Marginal cost is the incremental or additional cost of production which
arises due to one-unit increase in the production quantity. For example, the total cost of producing 10
units and 11 units of a product is ₹10,000 and ₹10,500 respectively. The marginal cost for 11th unit i.e. 1 unit
extra from 10 units is ₹500. This system of costing is also known as direct costing as only direct costs forms
the part of product and inventory cost.
Characteristics of Marginal costing:-

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i. Not a distinct method: Marginal costing is not a distinct method of costing like job costing, process
costing, operating costing, etc., but a special technique used for managerial decision making.
ii. Cost Ascertainment: In marginal costing, cost ascertainment is made on the basis of the nature of
cost. It gives consideration to behavior of costs.
iii. Decision Making: In the orthodox or total cost method, as opposed to marginal costing, the
classification of costs is based on functional basis. Under this method the total cost is the sum total of
the cost of direct material, direct labour, direct expenses, manufacturing overheads, administration
overheads, selling and distribution overheads.
Computation of profit under Marginal costing system:-
Particulars Amount (₹)
Sales xxx
Less: Variable cost xxx
Contribution xxx
Less: Fixed cost xxx
Profit xxx

Break-Even Point:-How much units must be sold so that entire fixed cost is recovered & profit is NIL.
At Break-Even Point:-Total contribution – Fixed cost = Zero/NIL or Total contribution = Fixed Cost

Break Even Point (In value) or Break Even Sales =

Break Even Point (in units) =

Cash Break Even Point =

Example:-
Fixed Cost = ₹ 2,00,000; Profit volume ratio = 40%; Cash fixed cost = ₹ 1,00,000;
Contribution per unit = ₹ 5

Break Even Point = = ₹ 5,00,000

Break Even Point (in units) = = 40,000 units

Cash Break Even Point = = ₹ 2,50,000

Cash Break Even point (in units) = = 20,000 units

Formulas used in Marginal costing Chapter:-

Profit Volume ratio (P/V Ratio) = × 100

Variable cost ratio = × 100

Profit volume ratio + Variable cost Ratio = 100%

Profit Volume ratio (P/V Ratio) = x 100

Profit Volume ratio (P/V Ratio) = x 100

Profit Volume ratio (P/V Ratio) = x 100

Example on above formulas:-

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Selling price = ₹ 20 per unit; Variable cost = ₹ 12 per unit; current year sales = ₹ 25,00,000; previous year
sales = ₹ 20,00,000; Fixed cost = ₹ 2,00,000

i. Profit Volume ratio (P/V Ratio) = × 100 = 40% or x 100 = 40%

ii. Variable cost per unit = x 100 = 60% or x 100 = 60%

iii. Profit volume ratio = 40% + 60% =100%

iv. Profit volume ratio = x 100 = 40%

v. Profit volume ratio = x 100 = 40%

vi. Profit volume ratio = x 100 = 40%

Margin of Safety
Margin of Safety = Sales above the break even sales.
Margin of safety = Total sales – Break Even Sales
Margin of Safety (Sales) x Profit volume ratio = Profit
Contribution at MOS sales = Profits
(Break Even sales + Margin of safety) × Profit volume ratio = Contribution
Total sales = Break Even sales + Margin of Safety

Variable cost per unit =

Example on above formulas:-

Margin of Safety = ₹25,00,000 – ₹15,00,000 = ₹ 10,00,000
Margin of Safety = ₹10,00,000 x 50% = ₹ 5,00,000
Contribution = (₹15,00,000 + ₹10,00,000) x 50% = ₹ 12,50,000
Total sales = ₹ 15,00,000 + ₹ 10,00,000 = ₹ 25,00,000

Variable cost per unit = = ₹ 4 per unit

Absorption Costing:-
A method of costing by which all direct cost and applicable overheads are charged to products or cost centres
for finding out the total cost of production. Absorbed cost includes production cost as well as administration
and other cost. Fixed overheads are recovered using Pre-determined rate. (as it is considered as part of
product costing)
Format of Income statement (under Absorption costing)
Particulars Amount (₹)
Direct Material xxxx
Direct Labour xxxx
Manufacturing Overheads xxxx
Fixed* xxxx
Variable xxxx
Cost of Production xxxx
Add: Opening stock of finished goods xxxx
Less: Closing Stock of Finished Goods xxxx
Cost of Goods Sold xxxx

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Add/Less: under/Over recovery of overheads xxxx

Add: Administrative Overheads xxxx
Add: Selling and Overheads xxxx
Total Cost xxxx
Sales xxxx
Profits xxxx

*Using Pre-determined recovery rate =

Value of closing stock = x units of closing stock

Format of Income statement (under Marginal costing)

Particulars Amount (₹)
Sales (A) xxxx
Direct material xxxx
Direct Wages xxxx
Variable manufacturing overheads xxxx
Variable cost of goods produced xxxx
Add: Opening stock of finished goods xxxx
Less: Closing stock of finished goods* xxxx
Cost of goods sold xxxx
Add: Variable administrative, selling & distribution overheads xxxx
Total Variable cost (B) xxxx
Contribution (A - B) xxxx
Less: Total fixed cost (any type)(Manufacturing, Selling, Administrative) xxxx
Net Profit xxxx

*Closing stock of finished goods = x Number of units in closing stock

Note:-When in question production volume is different average cost per unit is given than we need to apply
the following formula foe computing the variable cost per unit.

Variable cost per unit =

Budget and Budgetary control

Concise Notes
Meaning of Budget and Budgeting:-
Budget: CIMA Official Terminology has defined the terms ‘budget’ as “Quantitative expression of a plan for a
defined period of time. It may include planned sales volumes and revenues; resource quantities, costs and
expenses; assets, liabilities and cash flows.”
Types of Budgets:-
 Capacity wise (it includes fixed & Flexible budget)
 Functions wise (Sales, Production, Direct material usage, Direct material purchased, R&D, S&D etc.)
 Period Wise (long term , Short Term and Current Budget)
 Master Budget
Budgeting: It is a means of coordinating the combined intelligence of an entire organisation into a plan of
action based on past performance and governed by rational judgment of factors that will influence the course
of business in the future.
Objective of Budgeting:-
 Planning

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 Directing & Coordinating

 Controlling
Budgetary Control
CIMA has defined the terms ‘budgetary control’ as “Budgetary control is the establishment of budgets relating
to the responsibilities of executives of a policy and the continuous comparison of the actual with the budgeted
results, either to secure by individual action the objective of the policy or to provide a basis for its revision.” It
is the system of management control and accounting in which all the operations are forecasted and planned
in advance to the extent possible and the actual results compared with the forecasted and planned ones.
Budgetary Control involves:-
 Establishment of budgets
 Continuous comparison of actual with budgets for achievement of targets.
 Revision of budgets after considering the changes in the circumstances.
 Placing the responsibility for failure to achieve the budget targets.
Objective of Budgetary control system:-
 Portraying with precision the overall aims of the business
 Laying down the responsibilities of each of the executives and other personnel
 Providing a basis for the comparison of actual performance with the predetermined targets
 Ensuring the best use of all available resources to maximise profit or production
 Coordinating the various activities of the business
 Engendering a spirit of careful forethought
 Providing a basis for revision
 Drawing up long range plans with a fair measure of accuracy
 Providing a yardstick against which actual results can be compared
Master budget:-
When all the necessary functional budgets have been prepared, the budget officer will prepare the master
budget which may consist of budgeted profit and loss account and budgeted balance sheet. These are in fact
the budget summaries. When the master budget is approved by the board of directors, it represents a
standard for the achievement of which all the departments will work.
Zero- based Budgeting (ZBB) is defined as ‘a method of budgeting which requires each cost element to be
specifically justified, although the activities to which the budget relates are being undertaken for the first
time, without approval, the budget allowance is zero’.
Performance Budgeting (PB): A performance budget is one which presents the purposes and objectives for
which funds are required, the costs of the programmes proposed for achieving those objectives, and
quantities data measuring the accomplishments and work performed under each programme. Thus PB is a
technique of presenting budgets for costs and revenues in terms of functions.
Budget ratio:-
These ratios provide information about the performance level, i.e., the extent of deviation of actual
performance from the budgeted performance and whether the actual performance is favourable or
unfavorable. If the ratio is 100% or more, the performance is considered as favourable and if ratio is
less than 100% the performance is considered as unfavourable.
Ratios usually used by the management to measure development from budget.

Efficiency Ratio = x 100

Activity Ratio = x 100

Calendar ratio = x100

Standard Capacity usage Ratio = x 100 Maximum capacity

Actual capacity usage Ratio = x 100 Maximum Capacity

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Actual usage of Budgeted Capacity Ratio = x 100

E.g. Standard working hour = 8 hours per day of 5 days per week; Maximum capacity = 50 employees Actual
working = 40 employees; Actual hour expected to work per 4 week = 6400 hours; Standard hour expected to
be earned per 4 week = 8,000 hours; Actual hours worked in the 4 week period = 6,000 hours; Standard hour
earned in the 4 week period = 7,000 hours. Total period is 4 week. 1day holiday.
Answer:-

1. Efficiency ratio = x 100 = 116.67%

2. Activity Ratio = x 100 = 109.375%

3. Calendar Ratio = x 100 = 95%

4. Standard Capacity usage Ratio = x 100 = 80%

5. Actual Capacity usage ratio = x 100 = 75%

6. Actual usage of Budgeted Capacity Ratio = x 100 = 93.75%

Space for Notes

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